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Challenge for SEC: Preventing fraud in new fundraiser

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Crowdfunding has generated buzz in the life sciences sector for years, but the passage of the federal JOBS Act laid the foundation for action.
In brief, the 2012 JOBS Act allows smaller, non-public companies to raise up to $1 million during a 12-month period, provided certain conditions are met. The businesses can raise money from credited or unaccredited investors free from certain regulations governing publicly traded companies.

Money can be raised through a broker or online, through a federally approved funding portal. Limits are placed on individual investments, based on a participant's annual income or net worth — which creates a wider pool of investors, but smaller denominations. The bill also raises the number of shareholders a company can have before being forced to go public.

Crowdfunding is intended to be less time-consuming and expensive than registering an initial public offering through the Securities and Exchange Commission. During debates in Congress, critics charged the bill was light on investor protections and fought for additional regulations.

The SEC is still writing the rules for enforcing the bill. The concern of some is that smaller investors can be more easily fooled because they will be less cautious when investing smaller amounts.

Greg Lastwoka, a Rutgers-Camden professor specializing in intellectual property and Internet law, said the JOBS Act makes it easier for small firms to secure standard investment capital without violating securities laws. Lastwoka said by limiting the size of investments, the legislation tries to lessen the risk of severe financial harm to individuals.

"It will be an interesting experiment to see whether the 'wisdom of the crowd' will help people steer clear of scams and fund the most promising new businesses," Lastowka said.

Mark Roderick, an attorney with FlasterGreenberg, in Cherry Hill, said while no law can fully prevent attempts to defraud investors, the Internet will bring more transparency to the marketplace than older methods of raising capital.

"A lot of crowdfunding investors are going to lose money," Roderick said. "The market will sort it out. Eventually, crowdfunding is going to be the new normal for entrepreneurs raising capital. It won't be a story 10 years from now."

Roderick said early-stage companies demand access to capital with fewer intermediaries. The best goal is to manage the process rather than try to reverse momentum, he said.

"The Internet is the perfect vehicle for cutting out the middle man," Roderick said. "Arguing that we shouldn't do this is like arguing we should prevent a tidal wave. It's going to happen."

E-mail to: tomz@njbiz.com
On Twitter: @biztzanki

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